CHAPTER – II

REVIEW OF LITERATURE

Contents Pages

2.1 Introduction……………………………………………………....19

2.2 Concepts and Definitions ............................................................... 19

2.2.1 Sickness - Meaning and Definition ................................ 20

2.2.2 Turnaround Management – Meaning and Definition .... 21

2.2.3 Turnaround Vs Restructuring or Rejuvenation or

Reorientation .................................................................. 22

2.3 Turnaround Response, Context and Process ................................. 23

2.3.1 Turnaround Response/ Strategy Content ....................... 23

2.3.2 Turnaround Context ....................................................... 31

2.3.3 Turnaround Process ........................................................ 39

2.4 Conclusion ..................................................................................... 57

References ............................................................................................... 59

REVIEW OF LITERATURE

2.1 Introduction

Research on turnaround in the past, especially in the western context (Slatter,

1984; Schendel et al. 1976; Davis 1993; Robbins and Pearce, 1992), has contributed a lot

of insights into how a sick company could be turned around. Many question the

generalisabilty of these findings across different organizational and environmental

settings. (Bruton, Ahlstrom and Wan, 2001). The findings in the western context need not

be applicable in other parts of the world and in different organizational forms. For

instance, the turnaround strategies found successful in the west proved less effective in

the South East Asian countries during the economic crisis in the second half of the 90’s

(Bruton, Ahlstrom and Wan, 2003; Ahlstrom and Bruton, 2004). Besides, there is also

reason to believe that the strategies adopted for the public and private enterprises differ,

given the nature and context of their working (Walshe et al., 2004). So it is essential to

take turnaround research into new domains which will clarify the vital elements of

turnaround in different environmental contexts. The present study is an attempt to unearth

the factors that explain the turnaround in the State Level Public Sector Enterprises of

Kerala. Towards developing a theoretical framework for the study, the researcher has

surveyed the available literature on Turnaround and its related topics. This chapter

presents the literature which the researcher has reviewed.

The chapter is divided into two main sections. Section 2.2 discusses the concepts

of Sickness and Turnaround Management. Section 2.3 deal with the three main aspects of

turnaround which received considerable attention from the academicians, viz, turnaround

response/ strategy content, the relevance of turnaround context and the turnaround

process.

2.2 Concepts and Definitions

This section discusses the meaning and definitions of Sickness and Turnaround

Management to develop a conceptual clarity regarding these two terms. With regard to

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Turnaround, comparison was also made with similar concepts to place the meaning of

Turnaround in the correct perspective.

2.2.1 Sickness - Meaning and Definition

Industrial sickness means different things to different people, depending on the

stake they have in the affairs of a company. To a layman, a sick unit is one which is not

healthy; to an investor, it is one which skips dividends; to an industrialist, it is one which

is making losses and tottering on the brink of closure; to a banker, it is a unit which has

incurred cash losses in the previous year and is likely to repeat the same in the current

and following years (Nadkarni, 1983). As a consequence, there are numerous definitions

of industrial sickness, some of which are rather vague, others are more clear-cut. (Falk,

2005; Biswasroy and Patro, 2006; Gupta, 1990). Since a detailed exploration of all such

definitions is outside the scope of this chapter, we discuss here some definitions given by

the statute and government authorities in India.

The prominent official, legal definition of sickness in India is stated in SICA,1985

as “ an industrial company (being a company registered for not less than five years)

which has at the end of any financial year accumulated losses equal to or exceeding its

entire net worth and has also suffered cash losses in such financial year and the financial

year immediately preceding such financial year”. SICA applies to both private and public

sector companies, though the latter have been brought within the purview of the SICA

only in 1991. The SICA’s definition of sickness, however, has been criticized primarily

for identifying only terminally sick firms for which any reorganization or rehabilitation

package would come too late (DPE, 2005). Second, the SICA may mistakenly declare

non-sick firms as sick if companies fudge accounts to get shelter under the BIFR (Soni,

1999).

Another legal definition of sickness was found in the provisions of the Industries

(Development and Regulation) Act, 1951 (IDRA, 1951), which devotes a whole chapter

for the ‘Liquidation or Reconstruction’ of industrial undertakings. Reconstruction is

recommended if a company is not in a position to meet its current liabilities out of its

current assets (Chapter 18 FD (1) (a) of IDRA), but ‘public interest’ rules out winding it

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up. As under the SICA, reconstruction under the IDRA goes along with provisions of

financial assistance, suspension of legal proceedings, existing contracts and outstanding

obligations (Chapter III-AB, section 18 FB). In fact, the obviously similar tenor of the

relevant provisions in both laws gives rise to the question why a new law like the SICA

with a whole new bureaucracy had to be established.

The Board for Reconstruction of Public Sector Enterprises (BRPSE) considers a

CPSE as ‘sick’ if it has accumulated losses in any financial year equal to 50% or more of

its average net worth during 4 years immediately preceding such financial year and/or a

CPSE which is a sick company within the meaning of the Sick Industrial Companies

(Special Provisions) Act, 1985 (DPE, 2005). The BRPSE considers a company as sick

sufficiently earlier compared to a sick company as per SICA’s definition which requires

complete net worth erosion.

Even the legal and official definitions have considerable differences in the

treatment of what makes up sickness and it calls for a simple unambiguous definition of

sickness.

Unlike the use of the term ‘decline’ in the west, the term ‘sickness’ is found

popular in the Indian context (Manimala, 1991; Khandwalla, 2001; Gupta, 1983).

2.2.2 Turnaround Management – Meaning and Definition

Turnaround has been defined in many different ways. Generally speaking,

turnaround is essentially a period of performance improvement following a period of

performance decline. Turnaround is defined as the ‘reversal of a firm’s declining

situation’ (Schendal, Patton and Riggs, 1976) or a recovery from a decline in

performance (Khandwalla, 2001). In other words, it is “a process that takes a company

from a situation of poor performance to a situation of good sustained performance”

(Brandes and Brege, 1993). Turnaround management, therefore, is a management process

that reverses a decline or sickness situation and denotes management actions taken to

bring the firm back to sustainable good performance levels.

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Though there is a general agreement regarding the broader meanings of the term

sickness and turnaround, there is no unanimity in the treatment of what constitutes

sickness/decline and what constitutes turnaround/recovery among the researchers. The

term ‘decline’ represents a performance level lesser than Gross National Product (GNP)

growth rate (Schendal and Patton, 1976) or industry average (Robbins and Pearce, 1992)

or cut-off rate (Hambrick, 1983) or previous performance level. Also, there is no

unanimity in the treatment of what constitutes ‘recovery’. ‘Recovery’ is often referred to

as achievement of an enhanced performance level beyond industry average (Robbins and

Pearce, 1992) or GNP growth rate (Schendal and Patton, 1976) or cut-off rate (Hambrick,

1983) or previous performance level. Such differences in the treatment of both ‘decline’

and ‘recovery’ cast a shadow on the generalisability of various findings. Such varied

choices call for a simple but unambiguous definition of Sickness and Turnaround.

Therefore, the present study adopts the definition given by Prof. Khandwalla (2001)

which is very specific and clear. He states that “Turnaround is the recovery to

profitability from a loss situation” (p. 73). According to this definition, recovery is

essentially a period of profitability compared to decline, which is essentially a period of

loss. The profit/loss is adopted as a measure of turnaround performance. However, as

there are many concepts of profit like Profit before Tax (PBT), Profit before Interest and

Tax (PBIT), Cash Profit, Operating Profit, Gross Profit, Net Profit, etc., it is essential to

settle for one. In this context, the best way is to stick on to the most reported and accepted

measure of company performance (Khandwalla, 2001, p. 74). For the SLPEs in Kerala,

the Profit before any appropriations and prior period adjustments is a widely reported and

accepted measure of performance (BPE, 2006) which is nothing but PBT (Profit Before

Tax). This is also consistent with previous studies on turnaround (Hambrick, 1983;

Shamsud et al., 1996), which uses PBT as a measure of performance.

2.2.3 Turnaround Vs Restructuring or Rejuvenation or

Reorientation

The concept of turnaround is often used interchangeably with similar concepts

like restructuring (Cherunilam, 2000), rejuvenation (Stopford and Baden- Fuller, 1990),

23

and reorientation (Tushman and Romanelli, 1985). The attempt here is not to deeply

explore the similar concepts but to further clarify the concept of turnaround by placing its

essential features in relation to similar concepts.

Turnaround does require a life-threatening crisis or a negative performance trend,

which, if not corrected, will eventually lead to death. Restructuring and others do not

require a declining or sickness situation but can incorporate such a situation. They can be

effective tools in sick, stagnant and growing companies even with adequate profit.

Therefore, measures or strategies of restructuring or reorientation or rejuvenation can be

part of turnaround. However, it doesn’t mean that these are required only when the

business is sick. So, what makes turnaround distinct from other similar concepts is the

presence of sickness or decline situation and its focus in the reversal of sickness or

decline. According to Hambrick (1985) turnaround strategies differ from other strategies

because of the special conditions that turnaround situation imposes, i.e., limited available

resources, poor internal morale, sceptical shareholders and urgency.

2.3 Turnaround Response, Context and Process

Turnaround research has been largely focused on functional content or turnaround

response, i.e., what is actually done during turnaround attempt. Past research also

suggests that success of turnaround also depends on the context in which it was

undertaken and how well turnaround responses are matched to the specific circumstances

(Walshe et al., 2004). Researchers also developed some stage theories of turnaround that

could explain the turnaround called turnaround process. So, an attempt to unravel the

mystery of turnaround requires attention to be paid to content, context and process

elements (Pundit, 2000) of turnaround. The following section reviews literature relating

to turnaround content/response, turnaround context and turnaround process.

2.3.1 Turnaround Response / Strategy Content

Review on corporate turnaround literature (Balgobin and Pandit, 2001, Pandit,

2000; Schendal et al. 1976) reveals that researchers have given greater emphasis to

24

strategic content/turnaround response (what is actually done). It owes a lot to the strategic

management perspective adopted in most turnaround studies.

Strategic Management and Turnaround Management

Strategic management perspective assumes that the decline is the outcome of

faulty strategies or wrong implementation of an otherwise sound strategy. However, it

can be cured by an appropriate turnaround strategy. This perspective emphasizes the

importance of strategy in saving a sick company from death.

Turnaround strategies differ from ordinary strategies, as they are dependent on the

special circumstances that a turnaround situation imposes. Many researchers (Hambrick,

1985; Arogyaswamy et al., 1995) argue that the turnaround situation differs from other

strategic situations due to the limited available resources, poor internal morale, sceptical

shareholders, and urgency. Arogyaswamy et al. (1995), in their review of prior research,

identified the special conditions in a turnaround situation, which include an erosion of

external stakeholder support, deteriorating internal firm climate and decision-making

processes, and inefficient asset-cost utilization. These special conditions imposed by the

turnaround situation impact the selection of strategies/actions to improve firm

performance. Here, an attempt is made to present the strategy content literature to

develop deeper understanding on how various turnaround actions/strategies are selected

and implemented to enhance firm performance.

Strategic and Operating Strategies

Strategic turnaround strategies are the grand, long- term initiatives such as

diversification, vertical integration, new market share thrusts and divestment (Chowdhury

and Lang, 1994), greater R&D, introduction of new products, redefining the business,

diversification, vertical integration and divestment (Schendel et al., 1976). Here, the firm

may seek to compete in a new manner in its existing industry or to enter new industries

(Bruton and Rubanik, 1997). Hofer (1980) identified two ‘strategic’ strategies, namely,

product market refocusing strategy and dramatic market share-increasing strategy.

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Operating turnaround strategies/ actions are short-run tactics including cost-

cutting and asset reduction (Schendel et al., 1976; Hofer, 1980; Chowdhury and Lang,

1996) revenue-generation (Hofer, 1980; Chowdhury and Lang, 1996) and efficiency

improving (Schendel et al., 1976). Operating strategies are also called ‘Efficiency’

strategies as the primary focus of this strategy is efficiency improvement, i.e., it continues

to do what it has done in the past, but does it more efficiently (Bruton and Rubanik,

1997)

Entrepreneurial and Efficiency Strategies

Hambrick and Schecter (1983), by abandoning the strategic/operational

dichotomy, first introduced the concept of ‘Entrepreneurial’ and ‘Efficiency’ strategies.

Both of these strategies were found significantly associated with successful turnaround.

Entrepreneurial strategies are market-oriented. They focus either on resource acquisition

or revenue generation (Cameron, 1983) or on changes in market niches (Hambrick,

1985). Efficiency strategies are treated as a means of improving efficiency. They include

cost-cutting and asset reduction. Efficiency strategies are suggested to precede

entrepreneurial moves. According to Hambrick and Schecter (1983), there are two

entrepreneurial and two efficiency strategies. Their entrepreneurial strategy contains

revenue-generating and product market-refocusing strategy. Efficiency strategy includes

both cost-cutting and asset reduction strategy. It can be presented as follows:

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Figure 2.1 : Turnaround Strategies - Hambrick and Schecter (1983)

Source: Hambrick and Schecter’s (1983) classification (compiled by the author)

Unlike Schendel et al. (1976), Hambrick and Schecter have given a strong

endorsement of efficiency strategies in turning around firms in mature industrial- product

business. Their research has also added a new dimension to turnaround literature by the

use of multiple variables to represent a strategy, also called ‘gestalts’. Cluster analysis

revealed three turnaround types, two of which they had anticipated and one they had not.

They showed that 28 out of 53 turnaround firms practised what is called ‘piecemeal

productivity’, the one they had not anticipated, involving greater capacity utilization and

higher employee productivity. 19 firms seemed to practise ‘selective product/market

pruning’ involving liquidation of receivables and inventories, reduced borrowings, cut in

marketing expenses, push on higher productivity and quality, relatively premium-priced

goods and reduced capacity utilization, signifying a shift to profitable niches by

abandoning the fat. The third cluster consisting of only 6 firms, was labelled ‘asset and

Turnaround Strategies

Efficiency Strategies Entrepreneurial Strategies

Cost Cutting

* Cut backs in

administrative,

R&D,

marketing and

other

seemingly

discretionary

expenses

* Improved

management

of receivables

and

inventories

Revenue-

Generating

* Product

(re)introductions

* Increased

advertisement

* Increased selling

effort

* Lower prices

Product-Market

Refocusing

* Shifting

emphasis into

defensible or

lucrative niches

Asset

Reduction

* Disposal of

Assets

27

cost surgery’. This turnaround seems to be secured by sharp cuts in R&D, divestiture of

old plants and equipment, liquidation of receivables and inventories, strong push for

higher productivity and capacity utilization signifying a low-cost market position. One

drawback of Hambrick and Schecter’s (1983) study is that they did not study the causes

of the firm’s declining situation.

Retrenchment and Recovery

Retrenchment denotes a strong emphasis by the firm on cost and asset reductions.

Researchers have consistently found that firms attempting turnaround almost always

pursue cost cuttings and asset reductions to improve performance ((Schendel et al., 1976;

Schendel and Patton, 1976; Hofer, 1980; Hambrick and Schecter, 1983), which seem to

undermine their importance in the turnaround effort. Research up to 1990 appreciated the

role of retrenchment as part of turnaround, but failed to thoroughly investigate the value

of retrenchment in the turnaround process. Researchers (Schendel et al., 1976; Schendel

and Patton, 1976; Hofer, 1980;) have described retrenchment activities as only a tactic or

component of a short-term operating plan. Consequently, Robbins and Pearce (1992)

investigated the value of retrenchment in turnaround.

Retrenchment is a term used to describe a wide range of largely short-term actions

taken to stabilize the organisation, to stem its losses and to deal with the immediate

problems which have precipitated the crisis (Walshe et al., 2004). Pearce and Robbins

(1993) define retrenchment as the ‘deliberate reduction in costs, assets, products, product

lines and overheads’ of the firm. They argue that ‘retrenchment’ increases the chances of

successful turnaround and is an essential first step in the turnaround process (Robbins and

Pearce, 1992).

Robbins and Pearce (1992) argue that retrenchment seeks to stabilize declining

performance by reducing costs and unprofitable assets. The two objectives of

retrenchment are to ensure survival and to generate positive cash flow. Strategies under

retrenchment include liquidation, divestment, improving operational efficiency, product

elimination and head-count cuts.

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In the post-retrenchment period (or recovery phase), the firm may choose either an

‘efficiency’ recovery strategy or an ‘entrepreneurial’ recovery strategy. Firms whose

decline is caused primarily by internal problems tend to choose an ‘efficiency’ strategy,

while firms whose decline is caused by external causes tend to follow an entrepreneurial

strategy. The degree of retrenchment depends on how severe the firm’s decline is; asset

surgery is likely in deep declines and cost retrenchment is likely in less severe declines.

Retrenchment is found more fruitful for firms in deep decline than in less severe declines.

In a replicated study using the same data, Barker and Mone (1994) found that

retrenchment could improve performance only for firms in deep decline. When the

severity of decline was controlled, they found that retrenchment did not improve

performance. Hence, retrenchment as a base strategy for all declining situations is

questionable.

Decline-Stemming Strategies and Recovery Strategies

Arogyaswamy, Barker and Yasai-Ardekani (1995) have given another division of

strategies. According to them, firms attempting a turnaround pursue two distinctive

strategies: decline-stemming strategies that reverse the consequences of decline and

recovery strategies that yield a defensive competitive position for the firm. Decline-

stemming strategies address the consequences of decline, viz., erosion of external

stakeholders’ support, growing internal inefficiencies, and deteriorating internal firm

climate and decision-making processes.

Decline-stemming strategies constitute the first stage in their turnaround model

and can be either internal or external in direction. External strategies stop the erosion of

stakeholder support and renew the trust in top management. Internal strategies create

efficiency and stabilize the internal climate and decision-making process.

For turnaround to sustain, firms require successful implementation of Recovery

strategies. Recovery strategies are the management actions and policy changes that seek

to eliminate or cope with the cause of the firm’s decline in order to enhance turnaround

performance to acceptable levels.

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Bibeault’s (1982) suggested some important turnaround factors that contribute to

Turnaround such as instituting tight controls, changing people’s attitudes, understanding

business better, absolute control to management, and visible leadership.

Slatter (1984) identified 10 categories of turnaround elements. The most widely

used elements were asset reduction, change in management, financial control, cost

reduction, debt restructuring and improved marketing.

Khandwalla’s study (1989) of 10 Indian turnaround attempts revealed ten

categories of turnaround action consisting of both internal and external focus actions. The

internal focus actions were top management changes, credibility building actions by the

new management, attempts by new management to control finances and operations,

mobilization of staff for turnaround, coordinating activities, quick pay-off projects and

quick cost reductions. The external focus actions were negotiation with external

stakeholders, neutralization of external pressures, revenue generation and asset

liquidation for generating cash.

Hegde (1982) quoted in Manimala (2005) suggested seven turnaround elements

which includes an outside turnaround agent, heavy lay offs, rapid shifting of product or

plant portfolios, emphasis on technological updating through greater or more focused

R&D, selective strengthening of management systems, stronger commercial orientation

in the marketing function, and stronger profitability orientation in the production

function.

Manimala (1991) in his study of 28 western turnarounds identified 24 turnaround

strategies. They are: changes in staff patterns, positions and numbers especially in

reduction of staff; leadership/ownership change; financial restructuring; rationalization of

product mix; market orientation and focus on quality and customer service strategies;

organizational restructuring; tie up with other companies including mergers, acquisitions

and takeovers; information dissemination throughout the company; reducing excessive

dependence upon a single product, market, or sector; massive (re)training of employees;

public relations and liaison including those with government and even competitors;

financial incentives for managers/employees, reduction of overhead costs; introduction of

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new systems and procedures; focus on the core business; building a new culture;

redefining the business/evolving new strategies and customer service; reduction of

inventories; change in corporate identity/image; decentralized planning and strategy

making; increasing R&D activities; changes in the managerial cadre/professionalism;

engaging outside consultants; modernization of plant and machinery.

In a later study, Khandwalla (1992) identified two categories of turnaround

elements, foundational and strategic elements. Foundational elements are used by more

than 60 percent turnarounds. They include product mix changes, changes at the top,

marketing related actions, restructuring, cost reduction measures and plant

modernization. The strategic elements include the use of staff motivational devises such

as incentives, garnering support of stakeholders, participation of lower level managers in

turnaround-related diagnosing and problem solving, increased HRD, formal diagnostic

work, mass lay offs and creation of organisation wide consensus on core values and

required changes. According to him, turnarounds differ because of strategic elements and

similar because of foundational elements.

In a study covering 120 turnaround cases, Khandwalla (2001) considered 10

turnaround building blocks by grouping various turnaround actions. They are asset-cost

surgery, tighter controls and financial mending, restructuring and staff empowerment,

actions for operating excellence, cost shedding, product market refocusing,

transformational changes, managerial overhaul, strategic shift and sales push. It was

found that turnarounds differ mainly because of asset-cost surgery, tighter controls and

financial mending, restructuring and staff empowerment, actions for operating

excellence, and cost shedding. The two turnaround building blocks, strategic shift and

sales push differ moderately. Less difference was found with regard to the remaining

building blocks of product market refocusing, transformational changes and managerial

overhaul.

The review points out that the emphasis on strategies led many to suggest

universal prescriptions of various turnaround interventions (Walshe et al., 2004).

However, there is no unanimity among the researchers about the successful turnaround

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strategies. Studies differ as to what strategies make up successful turnaround. The

difference might be because of difference in the context in which the strategies were

implemented. The suggestions based on strategies could be misleading unless they take a

comprehensive outlook that addresses not only the content but also the context

perspective.

2.3.2 Turnaround Context

The turnaround process and content, if seen in isolation, could be misleading

unless due attention is given to the context in which they are undertaken. Past research

has isolated a few context variables that could play a crucial role in turnaround. They are

discussed below.

Causes of Sickness

Schendel and his colleagues (Schendel et al., 1976; Schendel and Patton, 1976)

first introduced the relevance of ‘cause’ element in the selection of appropriate

turnaround strategies. They distinguished between downturns resulting from poor

strategy (Strategic) and poor operation or poor implementation of an otherwise sound

strategy (Operational). If the decline was caused by operating problems, the cures chosen

were also of an operating nature. If the decline was caused by strategic problems, the

cures chosen were of a strategic nature. They have shown that 39 out of 54 firms that

formed part of their study declined due to efficiency problems and the remaining 15

owing to strategic failure. Though operational problems dominated decline, turnarounds

were more frequently associated with strategic moves, i.e., 25 strategic turnarounds

against 15 strategic downturns, and 29 operational turnarounds against 39 operational

downturns. Subsequently, the cause of decline is accepted as a major determinant of

turnaround strategies (Manimala, 1991; Bibeault, 1982; Robbins and Pearce, 1992;

Khandwalla, 2001; Barker and Barr, 2002).

The causes of decline are often dichotomized into internal and external - whether

they originate inside or outside the firm (Bibeault, 1982; Khandwalla, 2001; Ford, 1985;

Robbins and Pearce, 1992; Barker and Duhaime, 1997). It is argued that the firm’s

32

strategy may have been inappropriate for the given environment faced by the firm

(external), or that the firm was implementing its chosen strategy inappropriately

(internal). Research on turnaround consistently found that management actions /

strategies needed to address the causes of decline (Schendel et al., 1976; Hofer, 1980;

Robbins and Pearce, 1992). According to this view, strategic solutions should be used for

solving external, strategic problems and operating solutions for internal, operating

problems of firms facing decline. So, the firm needs to understand the principal cause of

its decline since its response needs to address the problems that created decline.

The studies on sickness in the western and Indian context have brought out the

major causes of industrial sickness. Bibeult (1982) found that internal factors accounted

for about 70 percent corporate sickness whereas external factors contributed only to 10

percent, with the remaining 20 percent were caused by a mix of both internal and external

factors. Manimala (2005) tried to summarize the major causes of sickness based on the

28 western cases he studied. The external causes are changes in the particular industry,

the economy as a whole and in the general environment. The internal causes were:

Continuance with production orientation resulting in poor quality of goods, poor

customer service, wrong positioning of the product and excessive dependence on

one product, one region or one market.

Strategy of growing too fast through unrelated diversification resulting in lack of

synergy, and cultural incompatibility.

Poor management of finances resulting in high leverage, delays in collection,

undercapitalization, etc.

Wrong personnel policies resulting in overstaffing, poor employee relations, lack

of adequate training of employees and promotion and retention of incompetent

managers.

Authoritarian and conservative attitudes of top management.

Technological obsolescence

Uncontrolled and non-focused R&D activities.

Poor management of inventories

33

Structural inadequacies

Inadequate information systems

Conflicts among stakeholders.

Manimala further opined that external factors, in fact, denote management’s

failure to adapt according to environmental changes and hence, they are basically internal

problems.

Other Indian studies (Agarwal, 1979; Prasad, 1982; Ramaswami, 1981;

Khandwalla, 1989; Manimala, 2005) have also isolated many important causes of

industrial sickness. The important external causes identified were transition from sellers’

to buyers’ market, inflation, import-export policies of the government, excise duties and

taxation policies, slow economic growth, recession and lack of demand, raw material

shortage and supply problems, power shortage, changes in the international market

conditions, technological changes, procedural delays at the government level and delays

on the part of financial institutions. The prominent internal causes were mismanagement

or corrupt management, lack of professional orientation among top management,

infighting within the ranks of management, weak board of directors, too much

centralization of management, wrong choice of technology, poor financial management,

poor cost control, inadequate marketing, disturbed industrial relations, dishonesty of

entrepreneurs, disturbed industrial relations, uneconomic wage levels, surplus work force,

underutilization of capacity, faulty production programme, lack of modernization, and

mismanagement of personnel function.

Biswasroy et al. (2006) have found that delay in project implementation, improper

management, financial indiscipline, underutilization of capacity, diversion of funds and

labour problems are the internal causes contributing to sickness. The external causes

contributing to sickness are recessionary trend, changes in the fiscal and monitory

policies of the government, non-availability of raw material and shortage of power.

A Reserve bank of India study quoted in Morris (1982) identified that about 52

percent of the units went sick because of mismanagement, 23 percent by market

34

recession, 14 percent by faulty initial planning and technical defects, nine percent by

power and raw material shortage, etc., and two percent by labour problems.

A study covering 120 turnaround cases (Khandwalla, 2001) suggested eight

categories of external causes contributing to sickness. They are recession, intensified

competition, adverse government actions/policy changes, sharp increase in bought out

costs, adverse political situation, infrastructural problems and adverse technological

changes. The internal causes identified were complacency, lack of planning, bad

industrial relations, lack of professionalism, ill-timed or inappropriately executed

expansion/diversification, lack of responsiveness to market, poor coordination and

internal conflict, bureaucratic management, poor functional management, bad customer

service, reckless acquisition, and corrupt management.

Both Indian and western studies pointed out the dominance of internal causes in

company sickness over external causes. Though differences exist with regard to many

causes of sickness, researchers have near unanimity with regard to poor management or

mismanagement as the main reason for industrial sickness.

Triggers

Declines do not automatically lead to turnaround action (Stopford and Baden-

Fuller, 1990). For turnaround to begin, it requires certain triggers that are likely to force

management / government to seriously pursue turnaround attempt. Certain events, like

financial crisis involving salary cuts or salary break, are likely to generate an

organization-wide consensus regarding the need and urgency of pursuing turnaround. In

some other cases, a threat of closure or ownership change may induce an array of

organization wide actions to improve performance. A change in top management may

also lead to new initiatives at the enterprise level to achieve turnaround.

Grinyer et al. (1988) found that decline does not automatically lead to sharp-

bending actions but the latter require triggers. The new chief executive is cited as the

most prominent trigger for change by 55% of firms that participated in the study. This is

followed by recognition by management of problems (35%), intervention by external

35

bodies (30%), change of ownership or threat of change in ownership (25%) and

perception by management of new opportunities (10%). Their study also found links

between the various causes of decline and events triggering sharp-bending changes. If

the causes of decline were external, the triggering event tended to be an intervention by

external institution e.g. financial institutions, stock market authorities. Actions in

response to poor management seem to get induced by the new executive and/or change or

threat of change in ownership.

Past researchers are almost unanimous in proposing that declining firms’ CEO or

top managers be removed or replaced to initiate a turnaround attempt (Bibeault, 1982;

Grinyer and Spender, 1979; Slatter, 1984; Nystrom and Starbuck, 1984; Mueller and

Barker, 1997; O’Neill, 1986). Such top-level changes occur when the internal factors are

perceived to be the major cause of firm sickness (Bibeault, 1982). Advocates of CEO

change argue that actions/strategies that led the company into decline were shaped by the

decisions of the firm’s leadership. Those who lived with them do not change such

decisions and strategies easily. They are likely to be more resistant to changing the

current strategy, owing to their identification with the strategies. They are more likely to

attribute the causes of firm decline to external factors as a cover to protect their self-

esteem and they do very little internally, which might cause further deterioration of crisis.

In this context, top management change is the most effective way of breaking down an

organization’s natural inclination to persist with prior strategies that led the company into

decline (Nystrom and Starbuck, 1984). Newly appointed managers will feel little

connection with the organization strategy, and will be in a better position to objectively

judge the firm’s performance problems. Researchers also have reported that top

managers’ perception regarding the causes of decline shifted from external focus to an

internal focus, as top managers were replaced (Hedberg et al., 1976; Starbuck et al.,

1978: Barker and Barr, 2002). Moreover, the CEO and /or new key top-level managers

are likely to bring with them new skills and expertise to run the organization. Recent

empirical studies also found support for the association of CEO or top management

change and successful turnaround (Barker and Patterson, 1996; Mueller and Barker,

1997) but not without dissent (Arogyaswamy et al., 1995; Daily and Dalton, 1995;

36

Bruton et al, 2003). This difference in empirical studies raises some important questions,

i.e., whether turnaround really requires a leadership change or only a change in

leadership style/quality or a change of both leadership and leadership style, an issue not

specifically explored in the past turnaround research. Improvements/ changes in

leadership quality can happen even without leadership change. A change in the

management style may be enough to bring about the required changes in the

organizations. In other words, any change in management without significantly

improving the quality of managing and decision making may not improve firm

performance.

Many studies in the Indian (Manimala, 1991; Khandwalla, 1983-84; Hegde, 1982;

Morris, 1982) and western (Bibeault, 1982; Slatter, 1984;) context reported

mismanagement or poor/faulty management as a primary cause of firm decline. Among

the Indian studies, there is almost near uniformity that the major cause of sickness is

management failure (Manimala, 1991). An RBI study on sickness covering 378 units,

published in the early 1980s, quoted by Morris (1982), estimated that about 52% of these

units fell sick due to mismanagement. The reports of various committees and task forces

that studied the performance of SLPEs in Kerala also cited mismanagement as the

primary reason for the dismal performance of this sector (GOK, 1998; ERC, 2001; SPB,

1990; SPB, 1997) and suggested various measures to counter it. Management-level

changes in SLPEs in general manifest themselves in different forms like new

appointments at the CEO level and/or new appointments at the middle level,

strengthening the board with new skills and expertise, professionalisation of top

management team, additional functional autonomy from government and ensuring a

sufficient tenure for the CEO. Such changes at the top level may result in the

improvement of leadership quality, top management commitment, quality of decision and

risk taking, and understanding between the Board and the CEO. Hence, changes at the

top level are likely to bring lots of improvements within the organisation which would

eventually improve the performance of the company.

37

Stakeholders

‘Stakeholder’ refers to any individual, group or institution that may affect or be

affected by the business activities (Freeman, 1984). They are government, trade unions,

employees, customers, suppliers, share holders (owners), creditors, general public, etc. In

the Public Sector context, government assumes the role of both regulator and owner.

However, unlike private institutions, PEs are exposed to controls by Parliament/State

legislature, administrative departments, the Minister concerned, government officials,

Planning Board, Audit departments (CAG), Vigilance agencies, etc.

Stakeholder management is a critical element that contributes to firm

performance, especially during the turnaround attempt (Hambrick, 1985; Arogyaswamy

et al., 1995). During decline, the firm experiences an erosion of stakeholders’ support,

and whatever support remains comes only at an increased cost. Managing stakeholders’

interests may be the most challenging job for the top management during turnaround. In

the public sector context, the top management needs to maintain good ties at the

government level. Support of the Minister in charge, government officials and politicians

may be extremely important even to rope in other stakeholders, e.g., banks and financial

institutions. Unless enough attention is given to stakeholders, they may withdraw their

support, which can eventually lead to firm failure. The more effective the stakeholder

management, the more the support they give during turnaround attempt.

Sickness Severity

Hofer (1980) first introduced the severity of decline as a contextual variable

influencing the selection of appropriate turnaround strategies. He identified two strategic

solutions, namely, ‘product-market refocusing strategy’ and ‘dramatic market share

increase strategy’, and four ‘operating’ strategies, namely, ‘revenue-increasing’, ‘cost-

cutting’, ‘asset reduction’ and ‘combination strategy’. Hofer found support for the

strategic-operational hypothesis: strategic cures for strategic problems and operating

cures for operating problems. Hofer’s main contributions were the inclusion of severity

as an important element in the selection of strategy and its relative importance in the

38

selection of cost and asset reduction (efficiency strategies). According to him, the choice

of ‘operating’ strategy depends on how close the company is to its break-even point.

Table 2.1

Closeness to BEP and Suitable Operating Strategies

Closeness to BEP Suitable Operating Strategies

Just below the BEP Cost cutting

Moderately below BEP Revenue increasing strategies

Far Below the BEP Asset reduction strategy

Extreme case Combination strategy

Source: Compiled by the author on the basis of Hofer (1980).

Hambrick and Schecter (1983) suggested Capacity utilization and Market share as

an alternative to Hofer’s break-even point to measure decline severity. According to

them, asset/cost surgery was pursued primarily by businesses with low capacity

utilization; selective product/market pruning was undertaken primarily by businesses

with relatively high capacity utilization; and the piecemeal strategy was followed

primarily by businesses with high market share.

Robbins and Pearce (1992) take a similar view where they suggest that the nature

of retrenchment depends on how deep the decline is. Asset surgery or asset retrenchment

is likely in deep declines, and cost retrenchment is likely in less severe declines. So,

retrenchment is taken as an essential first step in all turnaround situations. But the

treatment of retrenchment as a base strategy in all turnaround situations is questioned.

When their study was replicated using the same data, Barker and Mone (1994) found that

retrenchment contributed to performance gains only in deep declines. They found that

performance did not improve when the severity of decline was controlled. Thus,

retrenchment made sense only for firms in deep decline. Retrenchment as a base strategy

in all decline situations is, therefore, doubtful. Another approach to measure turnaround

39

situation severity is resource availability (i.e. underutilized or additionally available

human resources and available financial resources). The flexibility to strategic choice

depends on the resources available to the sick firm. If available resources are low

(relative severity is high), flexibility to alter strategy is limited, since neither human

resources nor slack financial resources are available for use. When the available

resources are high, relative severity is low because the firm has the flexibility to change

strategies and is in a better-off position to achieve turnaround (Arogyaswamy, Barker and

Yasai-Ardekani, 1995).

Firm Size

Firm size is likely to influence the selection of strategies being pursued during

turnaround. Big firms have increased capabilities for change because they have market

power, greater resource stockpiles, and specialized structures that can be used to exploit

opportunities (Barker and Barr, 2002; Ramanujan, 1984). However, others (Bruten et al.,

2003; Khandwalla, 2001) also argue that large size increases complexity and to bring

about any significant changes requires firms to implement changes throughout the

organisation. This will make change time-consuming and difficult for large firms.

Small firms have greater flexibility and may require little effort and resources to

introduce changes. However, smaller firms often lack resources to undertake major

strategic reorientations. This restricts the firm’s ability to introduce changes during

turnaround attempt and consequently to reap the benefit of improved performance. In

this context, it is worth exploring whether size influences the selection of strategies and

the subsequent changes in performance.

2.3.3 Turnaround Process

Researchers (Grinyer and McKiernan, 1988: Robbins and Pearce, 1992; Bibeult,

1982; Khandwalla, 1989; Manimala, 1991; Hambrick, 1985; Arogyaswamy et al., 1995)

have proposed many process models and theories to describe successful turnaround as

something taking place in a number of stages or phases. Some earlier models (Hambrick,

1985; Grinyer and McKiernan, 1988: Robbins and Pearce, 1992) assume that these

40

phases occur sequentially one after the other and rather independent of one another. Later

models (Arogyaswamy et al., 1995; Balgobin and Pandit, 2001) tried to look at

turnaround as a series of overlapping and interdependent phases rather than a sequence of

independent phases. So, now we look at turnaround process as a series of complementary,

parallel (overlapping) and interacting stages rather than a few consecutive phases

operating independently. These stage theories and models help us to understand the

possible linkages and appropriate actions at the right time at the right place. The review

below will give an understanding of various turnaround process models available in the

literature.

Grinyer and McKiernan (1988) studied 25 UK cases of ‘sharp-bending’,

companies that underwent transitions to a much higher performance from a stagnating

performance level relative to their industry rivals. Though ‘sharp benders’ are not typical

turnaround cases, their insights seem to enhance our understanding of turnaround.

According to them, sharp-bending seems to begin with a dramatic crisis, a situation

caused by internal dissatisfaction over the gap between corporate aspirations and realized

performance. This gap may arise on account any of the several internal and external

factors. Next, the organizations may undertake a wide array of options that produce

results. To begin with, it analyses operational problems function- wise and then initiates

cost cutting. If these actions do not bring the desired result, then the firm may go for

modest changes of strategic nature. If these two steps are found inadequate, then the firm

may seek radical changes including major changes in technology, market served, etc.

Grinyer et al. (1988) found that appropriate level of response to achieve sharp bend was

operational, followed by administrative and strategic.

Donald Bibeault (1982), in an exploratory study based on descriptive statistics

derived from a survey of 81 companies and over 100 interviews with business leaders

involved in corporate turnarounds, has proposed a five-stage model of turnaround (see

figure. 1). The study covers 81 US-based conglomerate type organizations that achieved

turnaround during the 1970s.

41

Source: Authors presentation of Bibeault (1982) stages

The first two phases of the proposed turnaround process are predominantly

preparatory stages while phases three to five are action phases. The time frame for the

different stages varies.

The management change stage, the top management recognizes the performance

decline and decides to respond appropriately. According to Bibeault (1982), in about

seventy percent of turnaround situations, mismanagement is cited as a reason for

performance decline. Under-performing members of the top management team are

regularly replaced in the management change stage. The replacement of top managers is

compulsory if they are either directly responsible for the mismanagement or if they are

unable to take necessary internal actions to achieve firm turnaround. Thus, replacement

of CEO depends on the perceptions of top management regarding the causes of decline-

internal or external. Internal causes are considered controllable within the firm and are

usually the result of inappropriate management. In contrast, uncontrollable external

causes can be political or economic in nature, and might impose constraints on

management actions. As the responsible leader, the CEO is replaced especially if internal

reasons are perceived to be the cause for the performance decline. However, if the cause

of decline is clearly external, the change of management may not occur. Even if the cause

of performance decline is internal, the change of management may not happen, if the

CEO happens to be a major shareholder of the company.

In the evaluation stage, the viability of the company is assessed and a turnaround

plan is developed with priorities. The focus is primarily on ensuring firm survival through

Management

Change

Evaluation

Emergency

Stabilization

Return to

growth

Figure 2.2: Five- Stage Model of Turnaround

42

liquidity management. To develop a turnaround plan, the top management has to gain

sufficient understanding of the turnaround situation, the turnaround cause and

organizational conditions, to determine where the turnaround efforts need to be focused.

In the initial period of turnaround, the realistic target is to solve 80 percent of the

relatively easily solvable problems rather than get bogged down with the 20 percent of

more difficult problems. The turnaround plan, consequently, is based on the top

management’s prioritization of turnaround actions in the given context.

In the emergency stage, the focus shifts from problem recognition to action. The

most important goal at this stage is to ensure the firm’s survival by focusing on liquidity.

Retrenchment of assets and costs is the clear focus, as retrenchment is a short-term

activity to increase liquidity by reducing cash outflow and enhancing cash inflow. Firm

management, therefore, has to ‘stop the bleeding’ (Bibeault, 1982:99) by cutting costs.

Actions taken to reduce cash outflows include personnel lay-offs and plant or department

closings. Two assumptions underlie the retrenchment activities: Firstly, the personnel are

seen as a cost factor rather than a source of competency. Secondly, the short-term focus

on liquidity is governing the actions. Thereby, the long-term recovery strategy is

neglected for a focus on short-term liquidity assuming an inability to increase cash inflow

in the short-term.

Depending on the availability of time and monetary resources, retrenchment

activities might be more or less extensive. Accordingly, the emergency stage may or may

not be a harmful experience for the organization. If enough time is available in the

emergency phase, the firm should try to divest plants and unprofitable business units

through sales to strategic or financial buyers. Only if it is impossible to timely find a

potential buyer, the closing of parts of the business and disintegration of resources is

unavoidable for short-term liquidity considerations.

The retrenchment in the emergency phase leads the firm to concentrate on

business segments that achieve good profits or segments with promising gross margins.

As a result of asset and cost-cutting moves, many organizations come out of the

43

emergency stage with reduced revenue capacities and diminished resources, but with

stabilized liquidity and greater focus on core business.

With the containment of negative cash flows, the firm enters the stabilization

phase. In the stabilization stage, the strategic orientation shifts from short-term survival,

retrenchment and liquidity management, to long-term sustainability, and acceptable

return-on-investment. Profitability takes priority over cash flow, and management

systems get renovated, especially in the control systems.

If the company survives the stabilization phase with controlled profit growth, it

enters the return-to-growth stage. In this phase, the emphasis is on internal and external

development and growth. The company initiates planned exit from unprofitable or

futureless businesses and shift its focus to high potential businesses.

Internal development concentrates on revenue growth, new marketing initiatives,

new ways to broaden the base of the existing business, and options to increase the market

penetration.

External growth can potentially be achieved through an acquisition in the core

business segment financed through funds from disinvestments. In order to achieve

corporate growth, new products may be added, new markets penetrated and developed,

selling effectiveness increased and customer services improved.

The executives put in charge of turnaround might have led the company through

traumatic retrenchment experiences, and as a result they might not be suited to lead the

company in the return-to-growth stage since they might be incapable of creating a

positive internal atmosphere. In such cases, as Bibeault (1982) suggests, a replacement

of the turnaround management may be adopted for long-term growth of the company.

The turnaround process ends if the perception of the company leaders is that the

company has undergone a turnaround.

Moreover, Bibeault (1982) points out important restructuring options in a

turnaround situation. These options include the exit from the current industry by way of

sale or merger with a competitor, the potential to realize growth (and market share) in the

44

core segments through acquisitions, and the ability for the turnaround firm to acquire

financial resources through divestment of business divisions. The point is also clearly

made, that divesting a business is clearly preferable over retrenchment of the business,

since the divestment allows the firm to realize financial resources rather than building up

obligations from the retrenchment process and disintegrating resources.

Bibeault’s study (1982) covers 81 conglomerate-type organizations in the US

during the 1970s, and the process elements he proposes largely resemble turnaround

process adopted by these conglomerate-type organizations. Reviewing the companies

that Bibeault (1982) analyzed includes large organizations such as Electronic Associates,

Johnson & Johnson, etc. and underlines the notion that this turnaround process is

particularly oriented at the business set-up of large conglomerates. These findings may

have limited use in other types of business units or cultural environments.

Apart from this, Bibeault (1982) neither explicitly considers the negative effects

of retrenchment nor does he assess interdependencies between the early-liquidity driven

phases of the turnaround process and the later growth-driven phases.

In a theoretical contribution, Hambrick (1985) suggests a three-stage process

model of turnaround by incorporating the peculiar turnaround contingencies. Hambrick

argues that a turnaround situation differs from other strategic situations due to the limited

available resources, poor internal morale, sceptical stakeholders and urgency. Since these

conditions are special to turnaround situation, they influence all stages and actions of

turnaround.

45

A low level of resources, according to Hambrick (1985), is part of the turnaround

situation. Banks are usually reluctant to infuse more funds in a declining firm.

Consequently, one of the major challenges for the turnaround manager is to work with

the available limited resources to achieve firm turnaround.

In addition to limited resources, the turnaround manager is confronted with low

internal morale and dissatisfied personnel, which are consequences of the initial decline.

With an increasing crisis situation, a growing number of highly skilled and educated

employees leave the firm to work in a more stable environment. When crisis deepens,

poor morale, internal strife among personnel, and lack of confidence among employees

further deteriorate the organizational resources and competencies (Hambrick and

D’Aveni, 1988).

Organizations largely depend on interrelations with stakeholders such as suppliers,

creditors, distributors, franchisees, and unions. In times of performance decline, the

Stages of Turnaround

Crisis Stabilization Rebuilding

Limited

resources

Poor internal

morale

Skeptical

Stakeholders

Urgency

Source: Author’s presentation based on Hambrick (1985)

Asset Reduction

* Disposal of assets

Figure 2.3: Stages of Turnaround

46

survival of the firm is partly dependent on the support of stakeholders and their

confidence in firm survival. If firms suffer from declining performance, stakeholders

withdraw their aid especially if they have better and more viable alternatives. The

withdrawal of stakeholder support increases transaction costs for the firm (e.g. suppliers

withdraw credit, banks increase interest rates), which further deteriorates resources and

contributes to the severity of the turnaround situation. Hence, the turnaround process

needs to incorporate stakeholder management so as to ensure continued stakeholder

support.

For Hambrick (1985), urgency is the result of the lack of time in the turnaround

situation due to the low (financial) resource base, deteriorated internal morale, and

decreased stakeholder support. Accordingly, timely actions and fast decisions are crucial

to firm survival. Moreover, urgency has implications for the way in which strategic

decisions are made, the substance of those decisions and the sequence of actions.

According to him, turnaround process consists of three action phases: Crisis,

Stabilization and Rebuilding (see figure 2.3). In the crisis phase, Hambrick (1985) argues,

a firm faces a survival-threatening situation. Correspondingly, the focus in the crisis

phase is on liquidity and stopping cash outflows to avoid bankruptcy and to create a solid

cash flow position. To create positive cash flows, retrenchment steps such as closing

down or divesting plants, and reducing headcounts might be inevitable. Hambrick

(1985), however, warns about the potential negative effects of retrenchment on internal

morale and stakeholder support.

If the survival of the firm is secured as a result of liquidity and cash flow-

enhancing actions taken in the crisis stage, the firm enters the stabilization phase. In the

stabilization phase, the primary aim is to get “breathing room” (Hambrick, 1985, p. 10).

Attention in the stabilization phase is directed towards increasing margins, fine-tuning the

production mix, targeting high-return market segments, and increasing the organizational

efficiency to build up resources that can subsequently be used to lead the firm to growth.

Control and information systems should be installed or improved. Management actions

remain operational in the stabilization phase.

47

Finally, in the rebuilding stage, management attention shifts from operational

issues to reconstructing the firm. In this phase, entrepreneurial activities such as new

product development, marketing campaigns, and asset renewal and expansion can be

started or accelerated. The rebuilding phase is similar to a general strategic management

situation, once the impacts of the characteristics of a turnaround situation, i.e. limited

resources, poor internal morale, sceptical stakeholders and urgency of decisions, have

gradually diminished and ultimately vanished.

Hambrick’s (1985) major contribution is the recognition of the contingencies that

impact the turnaround process, which conceptually makes strategic management clearly

distinct from turnaround management. Hambrick’s (1985) model gives a deeper

understanding of the stages in the turnaround process when studied in relation to its

contingencies. The effects of retrenchment, for example, turn out to be positive only if

assessed solely in the light of liquidity and cash flows. If internal morale and

stakeholders are considered, the overall effect of retrenchment can become negative.

Correspondingly, the conclusion of Hambrick (1985) concerning retrenchment strategies

is that they should only be pursued carefully, also taking into account the negative effects

of fall in internal morale and stakeholder support. However, he seems to focus more on

the action phases with lesser weight for the recognition-oriented aspects.

Hambrick (1985) also fails to explain the interrelations that exist between

different phases. It is assumed that the rebuilding phase deals with ordinary strategic

management issues rather independently of earlier phases in the turnaround process. If

valuable resources are retrenched in the crisis phase, however, they will be lacking in the

rebuilding phase. Accordingly, subsequent researchers have questioned the assumption

of independence between the turnaround process phases (Arogyaswamy, Barker and

Yasai-Ardekani, 1995).

Robbins and Pearce propose a model of the turnaround process (Robbins and

Pearce, 1992; Pearce and Robbins, 1993; Robbins and Pearce, 1993; Pearce and Robbins,

1994), which is derived partly from the preceding work of Bibeault (1982). Robbins and

Pearce found that turnaround management literature up to the 1990s had appreciated the

48

existence of retrenchment as part of the turnaround process, however, without thoroughly

investigating the importance and value of asset and cost-cutting strategies. Consequently,

Robbins and Pearce investigated in their research the value of retrenchment in turnaround

situation.

Robbins and Pearce (1992; 1993) argue that retrenchment is not only a measure to

enhance the liquidity position of a firm but much more an efficiency-increasing action. If

costs are reduced and inefficient assets are sold off, the overall/average efficiency of the

assets increases.

Robbins and Pearce proposed a two-stage turnaround process model, viz.,

retrenchment and recovery. They argue that turnaround efforts shall focus on retrenchment

since retrenchment and not strategic renewal is found to be the predominant determinant of

successful turnarounds (Robbins and Pearce, 1992; Pearce and Robbins, 1993).

Figure 2.4: A Model of the Turnaround Process by Robbins and Pearce (1992)

DECISION

POINT

CAUSE RECOVERY PHASE RETRETRENCHMENT PHASE

INTERNAL

FACTORS

EXTERNAL

FACTORS

SITUATION

SEVERITY

COST REDUCTION

ASSET

REDUCTION

STABILITY

TURNAROUND RESPONSE

A Model of the Turnaround Process

LOW

HIGH

EFFICIENCY

MAINTENANCE

ENTREPRENE-

URIAL

EXPANSION (STRATEGIC)

RECOVERY

TURNAROUND SITUATION

(OPERATING)

Source: Robbins and Pearce (1992)

Source: Robbins and Pearce (1992)

49

Turnaround situation severity is included as a contingency in the turnaround

process model, which was drawn from Hofer (1980) who found in a case study of 12

poorly performing firms that a link existed between turnaround situation severity and the

degree of cost and asset reductions necessary to achieve turnaround. However,

conditions of stakeholder support and internal morale are not explicitly modelled.

Similar to Bibeault (1982), Robbins and Pearce (1992; 1993) also argue that the

two main objectives for a firm in a turnaround situation are survival and attainment of

positive cash flows. To achieve positive cash flows, the distressed organization has to

engage in typical retrenchment activities, lowering cash outflows and improving the

liquidity position through liquidation, divestment, product elimination, and head count

cuts (retrenchment phase). These actions are based on the assumption that in the short

run cash inflows from operations cannot be increased and a situation of low liquidity can

only be resolved through lowering cash outflows. In the recovery phase, the aim shifts to

growth and development. Measures to accomplish organizational growth and

development are acquisitions, new products, new markets and increased market

penetration.

In the retrenchment phase, the firm seeks to stabilize the declining performance

and weak liquidity and cash flow position by cost and asset reduction. If a satisfactory

performance level is reached, companies can return to growth in the core business, but

might still decide to divest in other business areas. The firm is at a decision point

between the two stages (Robbins and Pearce, 1992; Pearce and Robbins, 1993): Either

the organization can pursue recovery maintaining the pre-existing strategy in a

retrenchment-reduced form or change the strategic orientation. Robbins and Pearce

(1992) argue that independent of the decision to change the strategic orientation,

retrenchment is universally an appropriate reaction in a turnaround situation. They

propose two major turnaround strategies: either an operating/efficiency turnaround in

which the pre-existing strategy is maintained and the turnaround is achieved through

asset and cost reductions, and a diminished resource base or strategic/entrepreneurial

50

turnarounds in which retrenchment is the foundation for an altered strategic orientation

for the return to sustainable growth.

Robbins and Pearce (1992) tested their two-stage turnaround process model and

found retrenchment to be an integral part of the turnaround process. They investigated 32

publicly held textile manufactures during the period 1976-1985, and found retrenchment

activities during the turnaround attempt to be positively related to turnaround success.

Firms encountering severe turnaround situations needed to pursue cost

retrenchment as well as asset retrenchment. Firms facing less severe situations

sufficiently reacted by retrenching costs. Cost and asset retrenchment together resulted in

the highest average level of turnaround performance. Based on their empirical findings,

Robbins and Pearce (1992) derive their process model and conclude that retrenchment

can be considered a core element in the turnaround process. Robbins and Pearce (1992),

similar to Bibeault (1982), model the turnaround process from a financial/liquidity

perspective without explicitly taking other contingencies into account.

Thus, they find a high utility for retrenchment activities, but negative effects of

retrenchment are neither modelled nor considered. Especially the proposition that

retrenchment in itself can be a strategy to achieve turnaround, and that accordingly

strategic renewal is less important than retrenchment, has invited strong oppositions in

subsequent studies (Arogyawamy, Barker and Yasai-Ardekani, 1995; Barker and Mone,

1994; Barker and Duhaime, 1997).

Retrenchment is, therefore, taken as an inevitable response to firm inefficiency

(e.g. Bibeault, 1982; Robbins and Pearce, 1992; Pearce and Robbins, 1993; Robbins and

Pearce, 1993; Pearce and Robbins, 1994). However, prior research indicates that

declining firms face severe problems in addition to inefficiency, such as dysfunctional

decision-making processes (D’Aunno and Sutton, 1992), deteriorated firm climate

(Hambrick 1985; Cameron, Whetten and Kim, 1987) and reduced stakeholder support

(Hambrick, 1985). Such contingencies are overlooked, making the retrenchment

argument win little acceptance later.

51

Arogyaswamy, Barker and Yasai-Ardekani (1995) in their theoretical contribution

tried to address the key criticisms of earlier models of turnaround. Preceding process

models were criticized for being linear, sequential and unable to explain the

interdependencies of turnaround process stages and the complexity of the process.

Figure 2.5: Two - Stage Contingency Model of Firm Turnaround by Arogyaswamy,

Barker and Yasai-Ardekani (1995)

Consequences of Decline

The two-stage integrative model proposed by Arogyaswamy, Barker and Yasai

Ardekani (1995) argues that the turnaround firm will undergo the following pattern of

events and actions. Initially, the firm’s performance declines as a result of either

misalignment with the firm environment, environmental hostility, or a mixture of both. If

the decline is not turned around, it will lead to three consequences: erosion of external

stakeholders’ support, growing internal inefficiencies, and deteriorating internal firm

climate and decision-making processes. A declining firm fails when a combination of

these consequences exhausts the firm’s financial resources and causes creditors to

withdraw their support from the firm.

Severity of

Decline

Level of

Available

Slack

Resources

Decline

Stemming

Strategies

Renewed

Stakeholder

Support

Increased

Efficiency

Stabilization of

Internal Climate

and Decision

processes

Foundation

Conditions for

Recovery

Strategies

Recovery

Strategies

Causes of Performance Decline

Causes of Performance Decline

Extent of

Turnaround

Source: Arogyaswamy, Barker and Yasai-Ardekani (1995)

52

Stage I – Decline-Stemming Strategies

If the above three consequences remain unattended, they may cause the firm to

fail or dissolve. In order to avoid failure, the authors propose that turnaround firms take

decline-stemming strategies that reverse or contain the three consequences of decline.

Decline-stemming strategies constitute the first stage in the turnaround model and can be

either externally or internally directed. Externally, they stop the erosion of stakeholders’

support, and renew their confidence in the top management. Internally, they create

efficiency and stabilize the internal environment of the firm. Decline-stemming strategies

must also be sensitive to the resource needs of various recovery strategies in stage II

(feedback loop). However, two contingencies influence initial decline-stemming

strategies: firstly, the severity of the performance decline, and secondly, the level of

organizational slack available at the time of the turnaround attempt.

The severity of the decline influences the extent to which erosion of stakeholder

support, inefficiency and deteriorating internal morale threaten the survival of the firm.

The effect of turnaround-situation severity on decline-stemming strategies depends on the

level of slack resources available. Organizational slack is defined as available manpower

and/or financial resources. In situations of low organizational slack, firms facing severe

performance decline are most vulnerable and as a result these firms are expected to

pursue decline-stemming strategies more intensely. High available slack may, on the

other hand, reduce the need for decline-stemming strategies. As slack can absorb

variability in firm performance, it can protect the firm at least temporarily against

dysfunctional effects of decline.

The first aim of the decline-stemming strategy is stakeholder management. The

strategy seeks to change the image that the stakeholders have of the firm in a way that

either increases or at least maintains their support

The second aim of decline-stemming strategies is to eliminate inefficiencies.

Increased efficiency by definition allows declining firms to better utilize their assets and

cost structures, which stabilizes the competitive position of the firm to some extent by

lowering costs, improving cash flows and reducing risk of insolvency in the short run.

53

Increased efficiency may be the result of retrenchment, downsizing the firm, increased

sales, or a combination of the three. The methods used to increase efficiency in declining

firms may vary, depending on what recovery strategy is chosen by the management.

The last goal of the decline-stemming strategy is stabilization of the internal

climate and decision processes. Arogyaswamy, Barker and Yasai-Ardekani (1995) argue

that firms can avoid the mechanistic shift in structure and decision processes, if the top

management enforces decentralization in structure, experimentation and free flow of

communication. They also suggest that employee involvement counters the mechanistic

shift and helps to maintain a positive internal climate. Additionally, uncertainty among

employees due to expectation of downsizing measures can be reduced, if the top

management maintains open communication during the turnaround attempt.

Stage II – Recovery Strategies

The outcome of stage- I creates a conducive atmosphere for recovery. Successful

recovery strategy in stage II is built on the foundation laid by successful decline-

stemming strategies in stage –I (e.g. stakeholders’ support, increased efficiency and

stabilized internal environment). Since,decline-stemming strategies deal with only the

three consequences of decline, any progress achieved in stage -I is likely to be short-lived

as it leaves the basic causes of decline largely unattended. So stage –II requires more

elaborate recovery strategies that address the basic causes of firm decline.

Recovery strategies are management actions and policy changes that seek to

eliminate or cope with the causes of the firm’s decline in order to enhance turnaround

performance to acceptable levels. Successful recovery strategies take into account the

cause of decline as well as the firm’s competitive position in the industry.

The cause of performance decline directly influences the effectiveness of various

recovery strategies. Organizational decline research proposes that the causes of a firm’s

decline can either be based in an industry contraction or because of poor firm-specific

adaptation to the internal and/or external environment (Cameron et al., 1988).

54

Decline as a result of industry contraction occurs when the industry as a whole

shrinks. The contraction reduces the number of firms in the industry, and most firms

suffer from performance decline as they all compete for a reduced resource base

(Whetten, 1987).

In contrast, firm-based decline occurs when the firm is not sufficiently aligned

with either its external or internal environment, and consequently performs worse than

the average firm in the industry. Most effective recovery strategies for firms in the given

competitive position and cause context are given in the following figure.

Table 2.2

Strategies Based on Causes of Sickness and Firms’ Competitive Position

Cause of Decline

Industry – Contraction based Firm-based

Long-term Industry Decline

Incremental strategy changes that expand

industry position through investments that

exploit existing resources and capabilities

Strategic reorientation

leveraging existing

resources and capabilities

with the latent value (few

firms by definition)

Cyclical Industry Decline

Incremental strategy changes that hold industry

position and strengthen historic resources and

capabilities

Long-term Industry Decline

Scaling back firm to viable customer segments.

Strategic reorientation if viable customer

segments dictate new resources and capabilities.

Otherwise, incremental strategy changes Strategic reorientation

creating new resources

and capabilities Cyclical Industry Decline

Incremental strategy changes that hold either

hold industry position or scale back those to

those customer segments which most value the

firm’s resources and capabilities.

Source: Arogyaswamy, Barker and Yasai-Ardekani (1995)

Wea

k

Fir

m’s

com

pet

itiv

e p

osi

tion

Str

on

g

55

For firm-based declines, they propose recovery strategies involving strategic

reorientation. Few firm-based declines have strong competitive positions and such firms

may focus largely on exploiting the firm’s existing but under-utilized resources and

capabilities. On the other hand, firms that have weak competitive positions may pursue

recovery strategies intended to build new resources and capabilities.

The stages in the turnaround process are interdependent rather than sequential.

The interdependency between both types of strategies, decline-stemming and recovery,

means that they need simultaneous consideration. However, it also means that success of

only one activity is not sufficient for turning the firm around. Initial or ongoing success

either of the decline-stemming or of the recovery strategies creates conditions that

facilitate success in the other stages.

The process model by Arogyaswamy, Barker and Yasai-Ardekani (1995)

comprehensively incorporates relevant turnaround contingencies, and reconciles much of

the preceding work on decline and turnaround. This turnaround process model differs

from other models by integrating different views on the turnaround process into one

model: Efficiency-oriented ideas of Robbins and Pearce (1992) on retrenchment are

combined with stakeholder and internal perspectives stressed by Hambrick (1985).

Arogyaswamy, Barker and Yasai-Ardekani (1995) stress the interconnectedness

of the three consequences of decline and also the difficulties that firms may have to face

while implementing decline-stemming strategies. The authors argue, for example, that

the implementation of retrenchment plans without considering all organizational

consequences may lead to reduced employee morale and commitment, increased

employee alienation and withdrawal of the most talented and skillful employees.

Retrenchment may create incremental or short-term efficiency gains and liquidity relief.

However, in the long run, such one-sided decline-stemming strategy may accelerate the

deterioration of the firm’s internal climate and decision process resulting in the

dissolution of the firm. Accordingly, the authors go beyond the liquidity argument and

address the negative impact of retrenchment that might seriously deteriorate the internal

climate making sustainable turnaround difficult.

56

Manimala (1991) proposed a five-stage model based on the analysis of 28 cases

from the developed countries. His stages include (1) Preparatory stage, (2) Arresting the

sickness, (3) Reorienting the business, (4) Institutionalizing the process, and (5) Growing

further. The Strategies in each stage are given below in Table 2.3.

Table 2.3

A Model of turnaround Stages and Strategies

Stages Strategies

1 Arresting

sickness

Credibility building by the turnaround agent

Mobilization of the organization

Reprieve from external pressures

Cost cutting/cost controls

Staff reduction, especially in non-productive areas

Quick pay off projects and actions

Asset reduction

Inventory reduction

2 Reorienting Redefining business

Change in corporate identity/image

Rationalization of product mix to eliminate loss making

ones and to focus on core business.

Modernization of plant and machinery

Shift from production orientation to market orientation

Tie-up with reputed companies for marketing

Focus on quality and customer service

Debt/capital restructuring

Organizational restructuring

Changes in the management cadre

Financial incentives for managers/staff

Training and retraining of employees

Information dissemination

Public relation and liaison

3 Institutionalizing Culture building through continued training, seminars,

focused programmes, slogans, rituals etc.

Introduction of new structures, systems, and procedures

including communication and coordination mechanisms

4 Growth Introduction of new products

Entry into new markets, especially international

Related diversification

Focusing and strengthening R&D

Mergers and acquisitions

Source: Manimala (1991)

57

Manimala’s (1991) preparatory stage includes Bibeault’s (1982) first two stages,

top management change and evaluation. However, he doesn’t claim chronological

distinctiveness and seems to admit the concept of overlapping stages. He has also given

strategies normally associated with different stages of turnaround, which are given below.

Khandwalla (1992), in his study of 42 turnarounds, identified actions in relation to

three stages of turnaround: initial phase, middle phase and final phase. His initial phase

actions include personnel changes especially at the top, disciplining the staff,

communication downward to co-opt the staff into the turnaround, roping in stakeholders,

control-seizing and cost-cutting. Middle phase actions include incentives and other staff

motivation techniques, attempts to weld the organization, revamping the plant and

vigorous marketing. Long-term strategic actions like diversification and product mix

changes including new products are relatively final phase activities. Khandwalla’s

classification of turnaround stages provides clues as to the timings of various turnaround

actions but he remains largely silent on the exact nature and purpose of actions at each

stage.

2.4 Conclusion

Turnarounds are of increasing relevance. With the far-reaching economic reforms

introduced in 1991, Public Sector Enterprises in India are exposed to global competition.

Since then, PEs have faced problems that they never had experienced under the protective

environment. These changes have put many PEs in trouble. Simultaneously, individual

PEs along with government departments got actively involved in the process of

turnaround. The SLPEs are an important component of Public Enterprises system in

India. Unlike central Public Sector Enterprises, SLPEs are owned and managed by State

governments. Their functioning heavily depends on the policies of respective State

governments and often on the policies of the Central Government. There is a dearth of

knowledge regarding the functioning SLPEs and the incidence of sickness among them

looks quite extensive. The insights regarding the turnaround attempts especially in the

SLPE context could be a powerful tool in the hands of policy makers and practitioners to

ward off sickness engrossed in the PEs in general and the SLPEs in particular. The

58

review of literature, in a nutshell, pointed out that the research on turnaround in India is

rather scanty except for a few studies in the form of Case studies (Khandwalla, 1989;

1992; 2003; Manimala, 1991). These studies have contributed lots of meaningful insights

about the turnaround of sick companies. However, no specific studies relating to

turnaround of the SLPEs of Kerala have been conducted and the present study is likely to

bring out the critical factors of SLPE turnaround in Kerala. The insights could be of

immense use to SLPEs in other states, which form a major constituent of Public Sector

Enterprises system in India. The next chapter will give a comprehensive picture of PEs in

India and more specifically the working SLPEs of Kerala.

59

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